Will Best Buy Be Bought?

Sep.18.12 | About: Best Buy (BBY)

In a previous article, we had summarized the problems that Best Buy (NYSE:BBY) was facing. One such problem was the edge that dot-com competitors like Amazon (NASDAQ:AMZN) had over BBY. Other problems included show rooming, very aggressive up-selling tactics by employees in stores, an unappealing buyback protection program, revamping of stores, restructuring, and cost cutting ($800 million in three years by shutting down stores). Since then, the stock price has declined by 14%. Best Buy founder Schulze now has 60 days to put forward a buyout offer. We recommend staying away from BBY due to the uncertainty surrounding the raising of the required financing, the acceptance of the offer by the board, and the company's inability to compete with very strong peers.

Q2 results were not surprising. The company posted EPS of $0.20, while analysts were expecting $0.31. Same-store sales have been declining (3.2% in Q2). Sales were down 2.8% year over year in Q2.

Richard Schulze, the founder of Best Buy, had proposed early in August a $10 billion ($24-$26/share roughly for the 80% stake he does not own) buyout plan, with measures like slashing prices to compete with the customer services provided by Amazon and Apple (NASDAQ:AAPL) stores, which he thinks would be better than the current "closing and reducing size of stores" turnaround strategy being taken by management. He said in a letter, announcing his intention to buyout BBY stock, that "there is no question that now is the moment of truth for Best Buy and that immediate and substantial changes are needed for the company to return to its market-leading ways."

Schulze now has access to all the private information needed to put together an interested group of investors (private equity sponsors) for taking Best Buy private. He has a 60-day period to give a fully financed offer to BBY's board. Schulze currently has two board seats because of his 20% stake. If the offer is not accepted, Schulze will not be able to continue acquiring BBY until January 2013, although he would still be allowed to present another offer at that time. If the second offer is not accepted by the board within 30 days, Schulze will be able to directly take his offer to investors through a shareholder meeting. Analysts say that Schulze will have to raise $6.5 billion to $7 billion in debt, along with funds from private equity, to be able to complete a buyout. It might be difficult to raise that much financing with the declining income, although it is not impossible, according to Credit Suisse. Analysts expect the interest on this debt to be around 8%-9%. BBY's long-term debt has around 7% interest. BBY's total debt and interest coverage ratio, at the moment, are $2.23 billion and 31 times, respectively.

Analysts have had mixed views regarding the chances of a buyout. Some are of the opinion that Best Buy's declining business will not appeal to private equity buyers, and it will go down the same way that Circuit City did -- although the company is still generating significant cash and does not have a bad balance sheet. The operating cash flow (trailing 12 months) is $3.29 billion. Total cash as at the end of the last quarter was $680 million. The company has an available credit facility of $2.5 billion. BBY is still the leader in electronics retail, with a 24% market share in 2011; however, it is losing its market share to fast-growing Amazon and Apple. BBY's market share was 25.6% in 2010, according to JPMorgan.

Meanwhile, Best Buy has named Hubert Joly as the company's CEO, starting in September. He takes over from former CEO Brian Dunn. On Sept. 14, the new CEO sold BBY stock worth $1.19 million at a price of $18.02 per share, although the company stated that this was for the purpose of covering taxes on stock grants.

The company has a short ratio of 2.8 days, with 15% of the float being short. The 52-week low stock price is $16.25, while BBY currently trades at almost $18.

We recommend staying away from Best Buy since its shares will likely see some volatility as information regarding the buyout, and other data, keeps coming out in the near future. Moreover, Schulze's ability to get the required financing and the board's approval is still doubtful, although not impossible. If the buyout does not occur, the competition -- Amazon, as well as Apple, Wal-Mart (NYSE:WMT), and Target (NYSE:TGT) -- will keep eroding BBY's market share in electronics retail.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Retail Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.